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May 7, 2012

What Is Money, and Why Is Europe So Messed Up?

Governments that fail to control money supply lack the power to keep domestic economies on track: FPA retreat

What is money? No—not the hopes, aspirations and goals we attribute to money. What is money itself, the physical property? Noting it’s a question even Alan Greenspan once struggled to answer, Dr. Stephanie Kelton, a professor at the University of Missouri-Kansas City, explained it to attendees at the 2102 FPA Retreat in Scottsdale, Ariz., on Sunday, linking it to the financial distress in which Europe currently finds itself.

“It’s always an interesting and important topic,” she began in her session, “Money is No Object: Accounting for Deficits, Taxes & Trust in the 21st Century.” “Money is a peculiar institution and no one really knows what to do with it, not even many leading economists.

The so-called “textbook theory of money,” she said, is best summed up by, “one of your own, Dick Wagner, who said, ‘money is the most powerful secular force on the planet, yet many view it with mystery and even mysticism.’ But at the same time, Adam Smith once said it’s human nature to ‘truck, barter and exchange.’”

Money eliminates the need for a “double coincidence of wants,” she said, meaning it’s more efficient than the clumsy barter system as other people don’t necessarily have to have exactly what you need at time of purchase. It developed from beads and feathers in early, primitive societies to precious metals during the rise of the nation-state to the paper form used today.

“Money is what money does,” Kelton added. “It is a unit of account with which we use to compare. Money, it can be said, is a veil over the real economy. It isn’t important in its own right, but for what it represents.”

Moving from the textbook theory to the “credit and state theory” of money, she said the origin of money can be found in credit and debt relations.

“Money was developed as we moved from primitive societies to societies with some sort of centralized authority, whether that be the church or temple, the government or monarchy. The goal was to move resources out of the private sector and into the public domain through the use of taxes, fees, fines and levies.”

Today, the rise of centralized governments mean there is typically one nation with one type of currency. The benefits of sovereign money produced by a corresponding sovereign country are:

It allows for “policy space and a degree of freedom, because despite what we’ve heard lately, if the government is the sole authority to produce money, it can never go broke. It can continue to issues currency and can therefore afford anything it needs that is denominated in said currency. It does not need to borrow its own currency.”

It can set interest rates and fiscal policy at any level; it does not need to rely on the market to do it for them.

“If you take intragovernment spending into account, the United States has a debt-to-GDP ratio of about 100%, yet interest rates are still negligible,” she explained. “In Japan, that figure is 200% and rates are also very low. But it is very different in euro zone countries that don’t produce their own currency or set their own interest rates.”

In 1999, she continued, euro zone countries decided to give up their sovereign currencies, which resulted in their money being divorced from the nation; they are users, but not producers of the currency.”

“They are no longer one nation with one money, but one market with one money. As a result, they don’t have the policy space or a degree of freedom and flexibility to deal with their crisis.

Her conclusion?

“Governments should be in control of their money supply, otherwise they lack the power to keep their domestic economies on track.